Price optimization is a capability that is finally making its way into the mainstream for companies in all industries. The term broadly refers to approaches for setting list or target prices that achieve a certain objective or goal, and that are based on some sort of data and mathematical formulas.
Some optimization approaches are intended to optimize yield on perishable products (like a seat on a flight soon to depart). Others are intended to optimize contribution margins. Still others are designed to balance both upside profit potential with the downside risk of losing business.
Whatever the goal, the CFO and the finance team are (or should be) part of the price optimization process.
One product can be sold at different price points into several different markets or end-use applications because customers perceive value differently and therefore have a different willingness-to-pay
Previously, price optimization was practiced only in certain verticals with massive amounts of transactional data like airlines and hospitality or retail and fast-moving consumer goods. It is now becoming the new norm for progressive companies in B2B industries like process manufacturing, industrial and high-tech manufacturing, wholesale distribution, professional and business services, transportation and logistics.
Traditionally, the impetus for taking advantage of price segmentation and optimization approaches has been a financial one. We will explore this first, and then note three key implications for customer experience as well.
The Financial Case
Most of these progressive companies have begun to leverage more advanced pricing capabilities for their ability to drive profit gains (10%-30% gains in operating profit) and subsequent returns on investment (projects with measurable ROIs of 500%-800%).
The reason for the strong benefits results is simple: a very small improvement in realized price translates into a very large increase in operating income. Because the gains in realized price carry no incremental costs like COGS or additional overhead, all the gains in revenue go straight to operating income.
When considering a typical Global 1200 company, various management consulting firms have noted for years that a 1% improvement in realized price typically translates into a 10%-12% gain in operating profit. This impact is significantly greater than any other profit lever such as variable costs, fixed costs, or sales volumes.
Deloitte has published a study in the Journal of Professional Pricing that noted an average benefit of 3.2% in realized price across over 100 pricing projects spanning five years. That translates into an average 32% increase in operating profit.
As one price-optimization software client, a Fortune 50 company, noted at their user conference: “How can you afford not to invest in this capability?”
Customer Segmentation Is Key
Where does the increase in realized price come from? Is it as simple as just raising prices?
The basis, especially in B2B industries, comes from being able to discern, measure, and then leverage how different customers value your products differently.
For example, one product can be sold into several different markets or end-use applications. The customers in those different markets or applications perceive value differently, and therefore have a different willingness-to-pay. These clusters of customers and products are essentially pricing segments that can be treated differently to maximize value-capture for the organization.
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